In almost all of the posts in this blog we have been talking about investments. Let us change track a little bit and talk about spending now. Many financial planners will frown upon spending and see it as a problem. My views on it are completely different. I believe that living a good life and striving to do the same will encourage you to earn more. At the end of the day greater income is the best insurance that you can have against inflation.
If you remember, in some of the earliest posts of the blog I had covered the lifestyle stages and the extended money equation for understanding spending and investment related surplus. You may want to go and read those posts once more to get a better understanding of what I will cover here. As you start your earning life and go through the various life stages there are two trends that will be visible to you with regards expenses. I will outline these two briefly in this post.
The first trend you will see is an upward push on your expenditure as you go across the different life stages. This is partly due to increasing numbers in your family as well as new types of expenses that get established with arising need. Examples are:-
- When you marry you become responsible for your spouse’s expenses. Of course, if both of you are working then these is a source of extra income too.
- Family numbers also increase with retiring parents and your own children.
- New types of expenses such as schooling of children, training on hobbies, additional insurances etc come up.
Note that the kind of expenses I am talking about here is largely mandatory and not discretionary. You definitely need good schooling for your children, the level of expenses that you want to incur for it can be a discretion.
The second trend that will become obvious is this. Over a period of time our discretionary expenses get converted into mandatory expenses and our indulgences get converted into discretionary expenses. Some examples to clarify this:-
- Usage of AC has become mandatory in most upper middle class households now.
- Most families have one car and a two wheeler and 2 cars are fast becoming a norm in Metro cities.
- Most people prefer to fly for vacations and not travel by train as before.
- Phones get changed every couple of years, TV every 4 years and other appliances as needed.
- Eating out has become common place and eating out in fancy places is not restricted only to special occasions now.
- Vacations outside India have become a necessity instead of the indulgence that they once were.
This can be termed as Lifestyle creep where expenses are pushed up to support lifestyle needs. Note that I do not see this as negative, simply something that we need to understand. Being ambitious on your spending is perfectly fine as long as you are having the same philosophy for your income. At the end of the day you will have the urge to earn more once you are clear that you need more money to live comfortably and invest properly for a secure future.
With these understanding in place let us look at an individual X who starts off earning at 25 years and follows the typical life stages that were described in a previous post. What happens to the expenses of X over the years?
- There is a normal increase in the expenses of X due to inflation.
- There will be an increase in his expenses as his family increases and new heads of expenses get created.
- Additional insurance needs as the family grows will push up expenses further.
- Asset purchases like a car or a home with loan will create EMI’s that will add to the expenses.
- Lifestyle creep will add expenses that were earlier absent or which occurred very rarely.
Once you have understood this well, you will see why our currently practiced methods of expenses projection are not correct. Most importantly, the lifestyle creep part is almost unaccounted for in all of our plans.
In my next post, I will try to give a personal perspective on how my spending pattern has changed over the years.
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